IRS May Eliminate Asset Discounts on Family Transfers

The Internal Revenue Service (“IRS”) appears to have set its sights on a popular strategy used by taxpayers to transfer wealth to successive generations while reducing or eliminating estate and gift taxes. At an American Bar Association Tax Section Meeting held in May of this year, IRS attorney Cathy Hughes indicated that new regulations may be forthcoming that could preclude the use of valuation discounts in connection with gifts of interests in family-owned entities.   

Here’s how it works. In a typical scenario, parents transfer assets such as a family business, real estate or marketable securities into a family limited partnership or limited liability company. By making gifts of minority, non-voting interests in such entities to children or grandchildren, parents can remove wealth from their taxable estates while retaining control over the underlying assets.  Furthermore, because of the lack of control and inherent lack of marketability for a non-voting interest in a family-owned enterprise, the transferred interest can be valued for transfer tax purposes at significantly less than the pro rata percentage of the overall value of the entity.

No details regarding the proposed legislation have been released. The IRS has long history of challenging intrafamily transfers designed to obtain valuation discounts.  Accordingly, analysts speculate that the new legislation will target lack-of-control and lack-of-marketability discounts for entities that do not conduct an active trade or business.  If the IRS has its way, estate planning using entities formed to hold passive assets such as investments may be a thing of the past.     

Ms. Hughes revealed that the new legislation could be announced as early as September of this year.  In light of the time it takes to register an entity with the Secretary of State and facilitate a transfer of assets, taxpayers considering estate planning with family entities are encouraged to act immediately.

Contact us with questions regarding family transfers and visit our Estate Planning services page to learn about the services that the Schneider Downs Tax Advisors offer.